How to prepare for a tax audit
Within the last year, the IRS announced that we should expect an increase in partnership audits, small business audits and non-cash company audits. Yet, early in 2014, we were informed of a decrease in actual audits by the IRS. Amid all these mixed messages, what should a small business plan for in terms of taxes and audits as it starts to close out 2014?
The IRS says it has three long-term goals: to improve service to make voluntary compliance easier, enforce the law to ensure everyone meets their taxpaying obligations and invest for high performance in people and technology. The IRS is under increasing pressure to maintain these goals with fewer resources and smaller budgets.
Individuals with high adjusted gross incomes and businesses with high dollar levels of assets have a higher likelihood of being chosen for an IRS audit. While some returns are selected at random by the IRS, others are selected due to computational errors; unusually large deductions such as charitable donations, or meals and entertainment expenses; large deductions that exceed related income; or a mismatch between what is reported on the return and what is reported to the IRS on Forms W-2 or 1099. For this reason, it is important that taxpayers review returns for computational errors and omitted information prior to filing.
Here are some tips if you find yourself under audit:
• Confirm that notices are legitimate. The IRS will never contact you by email or initially by telephone. Call the IRS directly to determine the legitimacy (at 800-829-4933 for businesses).
• Be professional and cooperative. Making it difficult for auditors to do their jobs will only frustrate them and cause them to be less accommodating.
• Be responsive and work to provide information in a timely manner. The IRS auditor will reduce nearly every request to a formal, written Information Document Request (IDR). If the request seems unreasonable or problematic, discuss it with the auditor immediately.
• Provide only the information the auditor is requesting. You want to be forthcoming without providing extraneous or unrequested information that will lead to more questions.
• Have your facts. Do not rely on conversations; provide important data and facts in writing so that you have an opportunity to confirm and communicate it in an accurate manner.
• Keep your records in good order and maintain them as frequently as possible. Accounting software and professionals are available to help you correctly report income, expenses, assets and liabilities. Organizing expense receipts and invoices by month as well as grouping copies of checks received with the related deposit slips are some helpful ways to stay on top of all the paper.
• The audit may extend to other years or related entities. For example, should an S Corporation return be audited, the agent may request to look at the flow of information to the owners' tax returns. Only provide this information if formally requested.
• At completion of its own exam, the IRS often will also issue a report to the tax authorities of the respective state(s), including any adjustments or finding of an audit. Also, in some cases it is the state, rather than the federal government, which initiates an audit, and the tips described above apply to them as well.
While the risk of an audit remains relatively low, there is still a chance of being selected. Most auditors are reasonable people who just have a job to do. Many audits conclude with a “no-change” letter after the auditor has gone through the audit process and confirmed the information shown on the return. To get to this result, have your information in good order, work with the auditor to provide sufficient information in a timely manner, and know when to seek the input of your tax advisor.
Jaclyn Johnson is a certified public accountant and senior tax specialist at Baker Newman Noyes. She can be reached at jjohnson@bnncpa.com.
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